Capital Gains Tax – change on the horizon?
The Chancellor of the Exchequer, Rishi Sunak, has announced that the date of the next Budget will be on Wednesday 3 March 2021. This is some 9 weeks away at the time of writing.
The Budget will set out the next phase of the plan to tackle the virus and protect jobs. Could we also see tax rises or reforms?
In July 2020, an inquiry into the UK tax system and a review of Capital Gains Tax (CGT) was launched within the space of two weeks. The Office of Tax Simplification (OTS), undertaking the CGT review, have published their first report which has a focus on the policy design and principles underpinning the tax.
Recommendations in four main areas, relating to CGT, have been made:
- More closely align CGT rates with income tax rates, or address boundary issues between CGT and income tax
- Reduce the level of the annual exemption
- Remove the CGT uplift on death
- Consider replacing Business Asset Disposal Relief (previously known as Entrepreneurs’ relief) with a relief more focused on retirement.
Various options to align or increase CGT rates are discussed in the OTS report.
Currently rates are 10% for basic rate taxpayers and 20% for higher rate taxpayers on most assets (including shares). Residential property gains are taxed at 18% for a basic rate taxpayer and 28% for a higher rate taxpayer. Business Asset Disposal Relief (previously known as Entrepreneurs’ relief) provides a 10% relief for business owners, generally on the sale of shares. Until 11 March 2020 this relief was available for £10m of gains, the limit after this date was reduced to £1m. The top rate of income tax is currently 45% for gross income in excess of £150,000.
The report highlights that multiple rates are confusing, administratively complex and don’t always provide certainty to a taxpayer straddling the basic and higher rate boundary, who won’t know their liability on a particular disposal until they know their total income for that tax year.
Therefore, it follows that we could see all CGT rates aligned to one single rate or an alignment closer to the current income tax rates. A complete alignment to income tax would remove the need for capital v income anti avoidance measures and is likely to require wider changes across both taxes.
There is also consideration in respect of the boundaries between CGT and income without an alignment of rates. Two particularly relevant areas for SMEs are the use of share-based remuneration and the accumulation of profits in smaller owner managed businesses (OMBs). One possible approach discussed is whether the profits accumulated within the business are taxed at dividend rates, rather than subject to CGT rates on a liquidation.
Aligning CGT rates with income tax is not a new concept, with this being the case for 20 years up to 2007/08.
Changes to align rates, or a change to the tax treatment of retained profits on a liquidation, will potentially see business owners paying up to 35% more on a business sale.
Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief)
The policy objective of this relief has historically been linked to both the stimulation of business investment and/or a relief when business owners retire. The OTS believe the relief is mistargeted if it is designed to encourage business investment, such incentive needs to apply at the time the investment decision is made, for example, the Enterprise Investment Scheme which already exists.
If the policy objective is for a relief of retirement, then suggestions in the OTS report are; increase the minimum shareholding to say, 25%, so it applies to owner managers rather than a broader group of employees, increase the holding period to ensure the relief goes to people who have built up their business over time and reintroduce an age limit to reflect that the intention is to benefit those who are retiring. Linking such a relief to retirement and/or age is not a new concept – CGT retirement relief existed until 1998 with that legislation forming the foundations of Entrepreneurs’ Relief.
When will changes apply?
Tax rises generally take effect from the start of the next tax year (6 April 2021) or the date of the budget. Given the pandemic continues at pace, it may be that significant changes are deferred to the 2022 Budget (Autumn 2021), to take effect for the tax year from 6 April 2022.
However, smaller changes or increases in rates, for the upcoming tax year are possible.
What can you do?
- Complete a disposal this tax year, for example, if there is a transaction in early stages of negotiations or due diligence, ensuring completion before the next budget date will protect against any rate increases.
- Bring forward any succession or retirement plans if commercially possible, for example, MBO transactions or share buy-back transactions.
- If there is no trade buyer or senior management team, consideration of Employee Ownership Trusts (EOT) could be an alternative option. An EOT is a special form of employee benefit trust that acquires the share of a company on behalf of its employees. Future profits or bank funding can be used to fund the purchase price and the sellers can secure a 0% tax rate if structured in a particular way.
- Use of family investment companies and/or transfer of assets to a spouse.
- Ensure efficient use of capital losses.
- Defer gains by utilising the EIS reinvestment relief.
Summary and next steps
Given the new mutant strain of the virus and a likely January lockdown for parts/all of the country, March is likely to be too soon for significant changes to the UK tax system. The Budget is expected to focus on the economic recovery and protection of jobs.
However, the record levels of national debt certainly mean that tax rises are inevitable at some stage. Therefore, whether you are considering an exit or looking to acquire a new business, the CGT regime will change in the future so engaging with advisers at an early stage will ensure any plans can be considered in light of the expected changes.
Contact Mark Kearsley or Murray McLean, Tax Directors, for further information or your usual Engagement Partner to discuss any future plans.